Slow Boat to China

04/30/2004 12:00 am EST

Focus:

Vivian Lewis

Editor and Publisher, Global Investing

"The clamor, the pleas, the threats became irresistible, so I decided to offer my subscribers a way to play the China card," quips global expert, Vivian Lewis. "But being contrarian to my tippy-toes, my way to buy China growth is via a Brazilian iron ore firm."

"Companhia Vale do Rio Doce (RIO NYSE) is a miner and exporter of iron ore but it also has interests in non-ferrous metals and energy. Apart from producing iron ore and pellets, RIO also is in exploration, mining, and processing of bauxite, gold, kaolin, potash, manganese, and other minerals. It is a large logistics player in Brazil, owning and operating railroads, marine terminals, and a shipping company. For the year, orders from Chinese steel mills fueled record earnings producing a net profit of $1.5 billion, an all-time record, equal to $4.03 per share. In 2002, it earned net of $680 million. Return on equity last year was 31.7 %, compared with 20.7% in 2002. Cash flow, measured as adjusted EBITDA, was also a record, reaching $2.1 billion.

"RIO will probably be the beneficiary of the largest overseas investment ever made by a Chinese company. Shanghai’s Baosteel with RIO is studying a project to build a steel plant in Brazil, which will help Bao lock in supplies. The plant will cost $2.5 billion, which the Chinese would rather spend on insuring themselves raw materials. Apart from Baosteel, a project for a steel plant in Maranhão, Brazil is being advised by German and Chinese engineering services firms. The world’s largest steel maker, Arcelor, also intends to be involved with the project. The proposed plant will produce 3.7 million tons per year of steel slab, with future expansion to 7.5 million tons. The project is the largest investment in Brazilian steel for many years and has the support of the Brazilian and Chinese governments.

"Vale do Rio accounted for 13.8% of Brazil’s entire trade surplus in 2003. RIO is in a sweet spot with the secular trend toward huge increases in Chinese demand for its ores, plus global recovery and a weak dollar. In the next three years, it plans to invest up to $1 billion in upping its iron ore output by 55% over current levels. Last year, the increase in sales was 63% from higher volumes and 37% from higher prices. China's impact on the market will keep both frothing. The firm has a healthy balance sheet (debt is only 90% of equity), high interest coverage, and modest leveraging. The stock is at a p/e of 12, which is not very aggressive. And you get a 3.4% dividend to boot. A recent profit decline due to currency swings has cut the share price to a very attractive level. Buy at $50."

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